Wednesday, April 27, 2011

How to Calculate the Value of a Zero Property

How do I calculate the possible market value of a zero cash flow property?

Values for zero cash flow properties are usually expressed as a percentage over the debt. That is to say, some percentage in excess of the debt. As an example, a brand new CVS zero with 25 years left on the lease/loan that fully amortizes would price in today's market at probably between 9% and 10% over the debt, such that if the loan balance were say $10Mil, then the total value be about $11Mil, meaning you could buy it with approx. $1Mil in equity. Further, the more seasoned that zeros become (older) the more valuable they tend to get, as you are closer to the day that you own it free and clear.

Another way to approach the problem would be to value the store as you would any other NNN property by applying a cap rate to the NOI. However, by applying a cap rate to the NOI, you would probably need to add at least 150 basis points premium to the cap rate. This helps account for the constraints of the zero deal (i.e. inability to refinance etc.). Said differently, If you have a deal that would otherwise trade at a 7.00%, as a zero it would probably value closer to an 8.5%.

It should be noted that both of these methods determine “gross” values and not a “net” value. That is to say that the net value (Gross Value minus the Debt) is the actual out of pocket cost to you to do the deal.

Lastly, as should be obvious, the real estate itself should play a role in it's valuation in that, location, possible reuse, and building condition may drive whether or not their is any residual value to the building at all in the absence of the tenant exercising their renewal options. A critical mistake that many people make when looking at zeros is to discount the real estate and simply view them as a security or abstract financial instrument. This is not the case, real estate fundamentals still apply.

2 comments:

  1. Another approach – which may result in Zero Cash Flow Asset Cap Rates LOWER than traditional Net Leased "Cash Flow" Asset cap rates – features Zero Cash Flow Asset valuation is determined by (x) NPV of residual value (with "as dark" value being a key consideration) PLUS (y) NPV of tax benefits (primarily if a 1031 exchange), LESS (z) NPV of taxes on “phantom income”, with creditworthiness of tenant being an overriding factor which can be incorporated via the discount rate (higher for lower rated credits) used to determine (x), (y) and (z). The fact that no refinancing risk exists for a Zero may prove to be a postive rather than a negative factor for many Zero Cash Flow net leased properties .

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  2. Thanks. Getting a right computation and knowledge in knowing and properly determining the value of a property would mean a huge help for you in knowing whether the property you are into a a profitable one or not at all. This also helps you in determining how much money will be needed to start out your investment. license real estate

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